Krispy Kreme loses sales-tax struggle

Doughnut maker had argued it should get same state exemptions as grocery stores

by Howard Fischer - Aug. 5, 2010 12:00 AMCapitol Media Services

An Arizona Krispy Kreme doughnut franchise has lost its fight to avoid paying state sales taxes because the Court of Appeals said the legal arguments had holes.

Lawyers for the franchises in the Valley said they were entitled to the same exceptions on taxes that grocery stores enjoy. The judges rejected the argument in a unanimous decision.

The lawyers said that most Krispy Kreme doughnuts are packaged to go, just like food from grocery stores.

The court also rejected two other arguments about why the franchise does not owe taxes.

Technically speaking, Arizona does not have a "sales tax." Instead, it has a "transaction-privilege tax."

The difference is that sales taxes are owed by the buyer. Transaction-privilege taxes are the responsibility of the seller, whether they collect them from customers or not.

The case involves sales made by franchise operator Rigel Corp. from June 1, 1999, to April 30, 2004. During that time, according to the ruling, 75 percent of its doughnuts were sold in quantities of a dozen or more and boxed to go.

Appellate Judge John Gemmill said the shop did not ask customers where they intended to eat the doughnuts. The stores did provide tables and chairs for the approximately 5 percent of customers who chose to eat the treats there.

The company collected taxes on all its sales.

The state Department of Revenue assessed transaction-privilege taxes based on all the company's take-out and on-premises sales. The company responded by seeking a refund of more than $2.3 million for the applicable period.

Gemmill, writing for the appellate court, said state law assesses taxes on all retail sales.

Food from grocery stores generally is exempt from taxes, and there are some exceptions for food from other kinds of shops.

One exemption says there is no tax levied on retailers whose primary business is not the sale of food "but who sells food which is displayed, packaged and sold in a similar manner as an eligible grocery business."

Gemmill said this appears designed for convenience, drug and department stores, which also happen to sell food items meant to be eaten at home.

In contrast, the judge said, the doughnut shops primarily are in the business of selling food.

He rejected the company's argument that the shops operate primarily as restaurants and that the doughnuts sold in boxes are incidental.

To support his point, he noted that only 5 percent of Krispy Kreme customers eat on-site.

The court also rejected the company's argument that it's not fair to have different treatment of the same item for tax purposes depending on the type of shop selling the item.

"The federal government distinguishes between retailers with respect to food stamps," Gemmill pointed out. "A customer may use food stamps to purchase doughnuts at a grocery store, but may not use them for purchases at a specialty-doughnut shop."

Attorneys for the company argued that, at the very least, it is not liable for taxes for doughnuts sold through its drive-through window. They said that really constitutes a separate business, with different hours than the walk-in shop.